1. Field of Art
This invention relates to the general technology field of event-based computer systems for financial market simulation, and in that field, more specifically to backtesting algorithmic trading systems.
2. Description of the Related Art
When writing an algorithmic trading system, it is necessary to test its efficacy before using it for live trading. There are currently two methods used for this. One is the use of shared test markets, where many different algorithms and systems use a real electronic exchange system, but where no settlement is required. The other common technique is to backtest against recorded historical data. This technique uses the historic data to determine prices at which the orders submitted by an algorithm are filled.
A problem with this technology area is that neither of the existing techniques suffices and an initial test period involving real trading is still required. Test markets are not a good place to test strategies in a competitive environment as they involve no real risk. The market is a complex dynamical system that is highly driven by feedback mechanisms. Ignoring such feedback is therefore unrealistic. Basing the strategy simply on historical data does not account for the feedback due to that strategy in question. Therefore, evaluating its performance without the realistic feedback effects cannot be a realistic strategic validation of the strategy. For example, if a strategy kept buying a stock in a real market this would push the price of doing so up, when filling orders based on historic data only, no change in price would be noticed.
In particular such feedback takes place in a number of orders of complexity. Zero order effects are the direct effects of exchange rules applied in response to order actions e.g. producing trade reports or changing published market depth. First order feedback is an embodiment of the fair market hypothesis under the assumption that the input market data stream represents fair market value, i.e. that over short time periods the algorithm tested can have a significant impact on the market, but that over longer periods this impact tends to zero, where impact is a measure of difference between input and output data. Higher order feedback represents any other more sophisticated feedback, e.g. the presence of arbitrage strategies, or other traders trying to game the strategy under test.